BoI, Treasury clash on spending

The Bank of Israel advocates higher taxes to protect public services; the Finance Ministry thinks it should mind its own business.

A new dispute has broken out between the Bank of Israel and the Ministry of Finance over what rate of growth is desirable for the state budget. Until 2010, public spending grew in line with the rate of growth of the population. That year, however, the Ministry of Finance, the Bank of Israel and the National Economic Council decided that the rate of growth of government services had to be in line with economic growth, but that it also needed to accord with a falling ratio of public debt to GDP. It was therefore decided to introduce a formula governing total public spending consisting of the desired level of debt (60% of GDP) divided by the current level (68%), multiplied by the average rate of growth in the previous ten years. This formula means growth in the state budget of 4% in 2013 and 2014, which is a higher rate than the current rate of growth of GDP.

This rule, which is not to the liking of either Prime Minister Benjamin Netanyahu or Ministry of Finance officials, since it is fairly expansive, is now up for discussion, and is likely to be revised in the next few days.

The rate of spending growth in the past year was affected substantially by the technical change in the method of measuring GDP by the Central Bureau of Statistics, which had marked effects on the main fiscal yardsticks. It significantly raised Israel's GDP figure and reduced the debt:GDP ratio, leading to a substantial rise in the level of spending under the existing spending rule (by more than 0.6%).

Now, the Ministry of Finance, the Bank of Israel, and the Prime Minister's Office are at loggerheads over the desired level of spending and the rate of spending growth. The Ministry of Finance and the Bank of Israel agree on two things only, which are that the level of debt must continue to fall, and that the fiscal deficit must be no more than 3% of GDP. Where they disagree is on how these fiscal goals should be reached.

The Bank of Israel believes that Israel's civilian spending, which is among the lowest in the OECD, cannot be reduced without affecting the level of state services. The central bank therefore believes that taxes should be increased, and that any change in the formula should be designed to produce a minimal impact on the rate of spending growth. The Ministry of Finance on the other hand believes that taxes should not be raised, especially direct taxes (income tax), and that the formula should therefore be changed in such a way as to reduce spending growth sharply. The Ministry of Finance would prefer to see an annual rate of growth of 2.5-2.7%.

Netanyahu to decide

Sources inform "Globes" that there are two main possibilities. One is to lower the debt target from 60% of GDP to 50%, which would reduce the spending growth rate. The other is to substitute for the average GDP growth rate over the previous decade (which stands at 4%) another variable, the natural growth rate of the population, which has been just 1.8% a year over the past twenty years. This would reduce the spending growth rate even more.

The person who will decide the matter is the prime minister, who is considered an economic hawk, and is therefore expected to decide in favor of the Ministry of Finance. The practical effect of adopting a more contractionary formula would be a drastic cut of NIS 5-10 billion in the 2015 budget, which does not look easy given current political alignments. Ministry of Finance source said however that, as has been publicized recently, "the ministry has hidden reserves" which will make it possible not to introduce dramatic cuts.

Talking to "Globes", Ministry of Finance sources criticized what they called the "excessive involvement" in the matter on the part of the Bank of Israel: "The Governor of the Bank of Israel has two main tasks: to manage monetary policy, and to act as economic adviser to the government. The question is, how much emphasis should be given to the second task. Karnit Flug has plenty of challenges, such as a strong shekel and a banking system without controlling shareholders, and she would be best advised to concentrate on these matters."

Published by Globes [online], Israel business news - - on December 25, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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